Fear, Uncertainty, Doubt, and the Domino Effect

Image credit: New York Times

by James A. Bacon

More than 600,000 Virginians have filed for unemployment claims since mid-March, when the COVID-19 epidemic started hitting Virginia and Governor Ralph Northam’s emergency decrees shut down large sectors of the economy. That’s roughly one person out of seven in the state’s workforce. After the first wave of closings, the number of new jobless claims has been shrinking. One can hope that we have seen the worst. Once federal helicopter money floats to earth and Northam shifts to a cautious, step-by-step rollback of the virus-control measures, one can hope, businesses will start rehiring.

Richmond economist Chris Chmura expects the national economy to contract at an annualized rate of 18.4% rate in the current economic quarter, another 1.0% in the third quarter, and then to begin growing again. “Employment at utilities, professional services and company headquarters should be back to 90% of pre-coronavirus levels by the fourth quarter,” she writes.

I hope Chmura is right. Judging by the snapback in the stock market, a lot of people seem to agree with her. I’m not counting on it. There’s a lot more bad news to come out.

That bad news comes in two categories — events we can reasonably predict, and events we don’t see coming. Let’s start talking about the kind of news we can predict.

Capital spending. Business hates fear, uncertainty and doubt (FUD), of which there is plenty. When faced with FUD, the vast majority of businesses typically by conserving cash. Publicly held companies halt their stock buybacks (something no one will miss) and cut dividends (something that many people will miss). Most importantly, they will delay capital spending. They won’t necessarily halt projects in process, but they will put future planned projects on hold.

Thus, for example, a construction contractor might have a solid project backlog extending six to mine months out. Those projects are still ongoing, and the construction workers are still employed. But as other businesses (and governments) start conserving cash and putting future projects on hold, if not canceling them outright, at some point that contractor’s work will fall off a cliff. Construction contractors are only the most visibly affected. Companies that supply equipment and spend heavily on big infotech projects will be impacted similarly.

This chart from the U.S. Census Bureau shows how important capital spending is to the economy, and what happened the last time, in 2009 and 2010, the U.S. had a major recession.

Depending upon the level of FUD and offsetting federal helicopter dollars, the falloff in capital spending could be in the neighborhood of $600 billion to $700 billion. (That’s an order of magnitude guesstimate based on five-year-old data).

In the last recession, utilities were the only sector of the economy that proved immune to the downturn. The manufacturing, mining, and transportation/ warehousing sectors saw significant declines in capital spending, while even the health care and information sectors were negatively impacted.

Manufacturing. Businesses aren’t the only ones who conserve cash in times like this. So do consumers. When people have been laid off, or are worrying about losing their jobs, people buy less stuff. When they buy less stuff, the people who manufacture that stuff suffer — not right away, but as inventories build up and the full dimensions of consumer cutbacks become clear. Thus we get stories like this from the Wall Street Journal today:

Factory furloughs are becoming permanent shutdowns, a sign of the heavy damage the coronavirus pandemic is exerting on the industrial economy.

Makers of dishware in North Carolina, furniture foam in Oregon and cutting boards in Michigan are among the companies closing factories in recent weeks. Caterpillar Inc. said it is considering closing plants in German, boat-and-motorcycle-maker Polaris Inc., plans to close a plant in Syracuse, Ind., and tire maker Goodyear Tire & Rubber plans to close a plant in Gadsden, Ala.

Mortgage markets. Meanwhile, the surge in joblessness has led to a corresponding spike in nonpayment of mortgages, putting stress on the financial companies that supply that debt. (Similar things are likely credit card companies and financiers of auto loans.) Thus, we get stories like this also from the Wall Street Journal today:

The U.S. mortgage market still functions much the same as it did before the last financial crisis. The coronavirus pandemic has exposed its cracks. The virus has forced millions of homeowners to stop making their monthly payments. At the same time, many mortgage companies aren’t positioned to help their customers though the economic collapse.

Many of them are nonbanks that don’t have deposits or other business lines to cushion the blow, and they have raised concerns that fronting payments for struggling borrowers will quickly drain them of capital.

The commercial real estate sector is likewise threatened as thousands of tenants — restaurants and small retailers — fall behind on their rents, or stop paying entirely.

Federal helicopter dollars are meant to inject liquidity into the system to prevent the system from freezing up. Maybe the Fed’s largely indiscriminate approach will work, maybe it won’t.

Corporate leverage. A a rational response to the ultra-low interest rate policies pursued by the Federal Reserve Board over the past decade, U.S. corporations have been substituting debt for equity on their balance sheets. They’ve been buying back and retiring stock and borrowing more. As a consequence, they are more leveraged than almost any time in U.S. economic history. Corporate debt was nearing $10 trillion toward the end of 2019.

Many businesses — most notoriously in the oil & gas sector — have borrowed heavily, and repayment of much of that debt now is looking precarious. Regulated by the federal government, the big money-center banks seem to be in sound financial condition. But the riskier lending has moved to unregulated “nonbank” entities. No one really knows what is out there, or how a collapse at one institution could trigger a domino effect on other institutions. While it is dangerous to venture any predictions, it is safe to say that a huge amount of risk lurks in this shadowy realm.

What we don’t know. While a handful of epidemiologists predicted that something like COVID-19 was likely to create a global pandemic at some point, very few people in government or the business world had processed that possibility. The U.S. Congress and the media were busy trying to impeach the president, and the Dow Jones Industrial Average was closing in on 30,000. (I recall a cover story of Barron’s magazine speculating how soon the Dow would hit 30,000, and how far beyond the market was likely to shoot — as any contrarian knows, a sure sign of impending doom). For nearly all investors, the pandemic came out of the blue. No one was prepared for it.

Just as the 2008 recession triggered hidden financial linkages that transmitted shocks from one sector of the economy to another, so might the COVID-19 recession. The global economy is more leveraged than it was ten years ago. Therefore, it is more vulnerable to systemic shock. Those linkages have not yet been exposed, but that’s not to say there aren’t there.

So, what does it mean? Governance at the federal level is hopeless. The only thing Republicans and Democrats can agree upon is to spend and borrow at unprecedented levels in the desperate hope that throwing together hastily concocted programs backed by unlimited trillions of dollars might salvage  the economy. Washington won’t change, and Virginians, comprising only one out of 40 Americans, are politically powerless to make it change. What Virginians can do is create an island of relative calm and tranquility by passing responsible budgets, pursuing growth-friendly economic policies, and relaxing restrictions that prevent people from getting back to work — in other words, by doing things that are as foreign to the ruling class as COVID-19 is to the human body.

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30 responses to “Fear, Uncertainty, Doubt, and the Domino Effect

  1. I appreciate the sentiment that “what Virginians can do is create an island of relative calm and tranquility.” It’s just not apparent to me that the third example you cite for doing this, “relaxing restrictions that prevent people from getting back to work,” is going to create any such island. Not enough time has elapsed yet to know if the “relaxing” already undertaken elsewhere will trigger the renewed surge in infections forecast by the medical community — but I would prefer that Virginia remain with the rest of the Northeast and proceed extremely cautiously. Let others take the risk of a gamble that so many predict is gross error; why should Virginia toss away the costly gains of the past two months just to satisfy an impatient minority? If the aggressive “reopeners” prove their actions don’t have the predicted consequences then follow them a month or so behind, but there is too much credible reason to believe their actions will backfire — and still too little testing available to know sooner than a month from now what the public health reaction will be. Let us be an “island” of sanity among the reckless, rather than one of them.

  2. James,
    Insightful perspective. It would be great if someone could add what will be the effects of increasing personal and business bankruptcies. Who will be left holding the bags? Is it the banks, credit card companies, or someone else. Also
    a large wave of mortgage foreclosures would, it seems, have a serious impact on those government-guaranteed loans (with tax dollars from you and I). Will the government be able to pay for all of those VA, VHA, etc. loans without going back to Congress for a 6th (or more) time?

    • You are thinking two steps ahead. Good for you. First step, what’s the impact on the economy? Second step: What’s the impact of the economic recession on government agency budgets, on higher-ed institutions, on quasi-governmental authorities (Washington Metro, airport authorities, port authority, housing authority, etc.) My impression is that the Northam administration has given some thought to short-term implications but it has revealed nothing about its thinking (if any) about broader or longer-term implications.

      • In war, it is called the general abandoning his troops still fighting on the battlefield. What is what Northam is doing and has been doing from the start.

        Steve said this in another way as early as several weeks ago.

        In Virginia, the only thing to fear is the government itself. It’s been that way since the spring and summer of 2017.

      • In regard to above comment:

        The CDC estimates that from 39 million to 56 million American have been ill this season (10/1/19 – 4/4/20) with the Flu. This flu has caused between 410,000 and 740,000 Americans to be hospitalized. And between 24,000 and 62,000 Americans died from the Flu this season.

        Has anyone found anywhere the number of flu cases, hospitalizations, and deaths in Virginia this season?

        So far I have found none in Virginia. Might that be true, none at all?

        Has the Coved-19 virus wiped out the flu in Virginia? Is it really that bad?

        Maybe, Virginia state experts just made it a little harder to find out.

        • What, its almost an hour after above comment was so posted, and nobody has yet found this season’s Virginia flu statistics?

          Could that really be?

          • Dick Hall-Sizemore

            I just looked at the agency website. I could not find data regarding the flu for any year. If it is there, it is well hidden. I have sent an e-mail asking for data.

          • Reed Fawell 3rd

            Thank you, Dick. That’s much appreciated.

          • Reed Fawell 3rd

            As time passes, now 20 hours since this flu issue was first raised into public view here on Bacon’s Rebellion, and 16 hours since our very own Fearless Fosdick Dick began his gumshoeing poking around the bowels of Virginia’s Health Department government, the emerging Virginia Flu Plot, like the Gunpowder Plot before it, thickens.

          • Reed Fawell 3rd

            Now some 28 hours have passed and still no one can explain how it is that flu has vanished from the face of the earth in the State of Virginia since early/mid April.

            Here is where trail vanishes:
            https://www.vdh.virginia.gov/content/uploads/sites/3/2019/12/Weekly-Influenza-Activity-Report.pdf

            Was the flu wiped off the earth in Va. by Coved-19? If so, was it a contract killing by the mob?

            Or,

            A clerical error by Governor’s office, by the usual suspect?

            Or,

            The lack of a functional gov. Health Department in Virginia?

          • Reed, the CDC said, “The week of April 4 was the last week in-season influenza burden estimates will be provided for the 2019-2020 season.”
            “The number of hospitalizations estimated so far this season is lower than end-of-season total hospitalization estimates for any season since CDC began making these estimates.”
            The public health lab chart on https://www.cdc.gov/flu/weekly/ shows a bottoming out as of week 14 (April 4).

            The info is on the VDH page: https://www.vdh.virginia.gov/content/uploads/sites/3/2019/12/Weekly-Influenza-Activity-Report.pdf as of 4/23/20.

            VDH shows 11,883 total flu infections in Virginia; for 2019-20; 127 outbreaks all season; 6 pediatric deaths; 2,695 pneumonia and influenza-associated deaths during the 2019-20 flu season. Does not give hospitalizations.

  3. I was with you until your last phrase.

    • “There are currently no comments highlighted”?!

      I dunno, let’s see if we get an honest report from Florida and Georgia. I really don’t mind letting others go, and I do mean “go”, before me.

      BTW, the last guy who tried to sell me on the “domino effect” certainly did not have my best interest at heart.

    • I’ve been to Warrenton. VDOT, or the city, needs to fix and widen their roads. Can’t move in that place.

      OTOH, culling the herd will work just as well, so let ’em open up.

      BTW, 100? Not enough to make a difference as a protest, nor a thinning.

  4. Well, I must say Jim’s graphics are improving. Looks like, for the horror part, he borrowed an old floating WW2 anti-ship mine from offshore Va. Beach, and got it rolling downhill like its gonna squish the guy running.

    But wait. Might Jim again be trying to scare granny with a virus?

    • Snowballing and going viral. Synonymous,no?

    • BTW, they still manufacture antiship contact mines. The “horns” are glass and somehow the seawater causes the fuse circuit to close. It’s a simple chemical detonator, and yes, there is probably a mine from WWII out there somewhere that could still work… boy that’d ruin a Carnial Cruise.

      And, mines have sunk more ships than just about any other weapon. The NK mining of Wonsan delayed a beach landing so long that the USO and Bob Hope greeted the Marines when they arrived.

    • Message from Wonsan to command

      “We have lost control of the seas to a nation without a Navy, using pre-World War I weapons, laid by vessels that were utilized at the time of the birth of Christ.” (3)

  5. How about some incrementalism? Many businesses can begin to bring in some, but certainly not all, of their employees. They might be able to open some sales and service channels. And for opening, there probably needs to be some different rules for different parts of states. The more dense areas probably will be last.

    • I don’t disagree with you. But, let’s be honest, this is economic Darwinism. The grapevine indicates that nearly every major tech firm is going to follow Google’s lead and not require in-person attendance until 1/1/21/ I suspect that most of the top 10% jobs will end up in WFH until 1/1/21 or later (if we see another major outbreak or 2 in the next 7 months).

      We need to be clear that we are basically going to say, “Bottom 90%, you experiment, die, and help build up herd immunity while the top 10% stay safe and healthy.” I’m not saying that you’re wrong in the approach you’re advocating, just that we are about to witness a very class-based moment that could get ugly if there is a massive spike in cases and deaths for those that returned to work.

  6. Yup. Everywhere you look there is gloom and doom on steroids!

    With respect to mortgages and investor-owned real estate. What happens if the mortgage or rent is not paid – to the holder of the debt?

    Certainly, they don’t get their money but how does that really hurt them except in terms of their profit and their ability to purchase more properties with their collected money?

    During the Great Depression, banks ended up owning thousands of properties but the banks did not go broke, in fact, after the recovery, the banks made out like bandits on all the repossessed properties they had gotten for pennies on the dollar. The real losers were the folks that had been paying their monthly payments… and no much they had paid back – even 90% of it, they lost the property and the bank got it for 10% of it’s book value.

    I also wonder just how many folks who have lost their jobs – that are service, entertainment and hospitality workers actually were home-owners and not rent-payers.

    Some other kinds of businesses were already dying and this just delivered the coup-de-grace.

    People who have wealth – generally do things with it that add to it. Many are fairly conservative – they don’t be the whole bundle, so what this does to them is pause. Those who were running high wire acts, yep, some of them are gonna get crushed.

    And the really perverse thing? Folks who do have money and want a safe place – T-bills !! Just PERFECT for all that govt spending and patriotic too… much better than foreigners buying that debt!

    😉

    • “During the Great Depression, banks ended up owning thousands of properties but the banks did not go broke, in fact, after the recovery, the banks made out like bandits on all the repossessed properties they had gotten for pennies on the dollar. ”

      Huh? 20% of all U.S. banks failed from 1930 to 1933 alone.

      • yep, what I said was wrong and dumb to say that.

        Many banks DID fail during the depression but who ended up owning their assets – both the already-forclosed properties and the debt paper for other farms not yet foreclosed?

        The point is that someone did and those folks who did had wealth and acquired more wealth as a result.

        Not arguing against wealth here – only that people at the lower tiers are the ones who suffer most during economic downturns.

  7. Have we been through Boomergeddon” yet?

  8. James Wyatt Whitehead V

    Just gave away an old Toyota I had in the driveway to an unemployed tradesmen who found a job but was looking for some wheels to get there. It was my grandmother’s car. I had been hanging on to it but I know grandma would approve. You know there is another domino effect each of us can unleash.

    • Yes, we are making progress in this Golden Age of information free to anyone willing to click a button; and progress in this Golden Age of the most expensive colleges and universities in human history. Institutions of learning where no one has to study, learn, and be tested for learning because every student gets an A or a B for simply ponying up his or her tuition and fees they pay to their schools for everything they desire and schools desire, save for anything having to do with teaching students real knowledge like real history, and testing them to insure they actually learned something worth learning in their four years of US higher education.

      Instead American students get the most expensive leisure time in world history for pampered senior adolescents.

      Yes, despite all of this, here on Bacon’s Rebellion, at long last, we can all agree on a single fact: American banks went broke during the Great Depression of 1930s.

  9. Good for you James! I don’t have a spare vehicle but I do intend to give my stimulus check to someone who needs work and I am more than willing to donate my time to help others in need.

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